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We find out why fund managers are warming to the Asian region again
Thursday 09 Apr 2020 Author: Ian Conway

As the city of Wuhan ends its 11-week quarantine, it seems that life in China is more or less getting back to ‘normal’. Although a handful of new virus cases are being reported, the draconian measures the government took to limit the virus mean the country is recovering just as the rest of the world goes into lockdown.

Cinemas and schools have reopened in many provinces and traffic is back to normal levels in the top 100 cities. The key manufacturing provinces of Zhejiang and Jiangsu which surround Shanghai are said to have been almost fully operational by late February.

Moreover, thanks to its tough measures to contain the outbreak, China’s government hasn’t had to deploy anything like as much fiscal stimulus as Europe or the US to protect its economy, although it may unveil a business ‘help’ package later this month.

NO V-SHAPED RECOVERY

There was positive news when the manufacturing purchasing managers’ index (PMI) rebounded from a record low of 37.5 in February to 52 in March, but as Eleanor Creagh, regional strategist at Saxo Bank, points out, the PMI reflects the monthly change and isn’t indicative of ‘v-shaped recovery’.

‘China’s manufacturing sector continues to face headwinds as the global demand shock presents a second wave of external demand collapse for the sector,’ says Creagh.

Louis So, co-chief investment officer of Hong Kong asset manager Value Partners, agrees: ‘In our view, the demand slowdown will impact China’s economy and corporate earnings. In general, earnings expectations are still too high for export-oriented stocks.’

DOMESTIC ECONOMY RECOVERING

Crucially, private consumption has picked up. China’s economy is now led by domestic consumption, with net exports making up just 17% of GDP last year compared with 31% in 2008, and its homegrown consumer goods companies are already back up and running.

Chetan Seghal, lead manager of the Templeton Emerging Markets Investment Trust (TEM), says the resilience of the domestic economy shouldn’t be overlooked.

‘Structural themes remain unchanged, with information technology and consumers playing key roles. While we have seen weak consumer sentiment impacting discretionary purchases and travel, e-commerce, internet and software companies are benefiting from an increase in online activities.’

In a recent survey by consultancy McKinsey, between 60% and 70% of Chinese consumers polled said they expected to resume ‘normal consumption or consume slightly more’ in the next couple of months.

Consumption is increasingly moving online, with domestic brands tending to react fastest, reflecting digital capabilities that are often more mature than those of international brands, according to McKinsey.

Teera Chanpongsang, manager of the £3bn Fidelity Asia Fund (B6Y7NF4), believes there are many new opportunities related to the rising middle class and their consumption of goods
and services.

‘One effect of the coronavirus tragedy may be to increase the penetration of online consumption still further, with online services such as e-tutoring, entertainment, and grocery delivery all receiving a forward push.’

ATTRACTIVE VALUATIONS

Another positive for investors looking at Chinese stocks is that much of the negative news is already priced in. The Hang Seng China Enterprises index and Hang Seng index are now trading below the 2008 global financial crisis level in terms of price-to-earnings and price-to-book ratios.

According to Yu Xiaobo, investment director and head of China business for Value Partners, Hong Kong stocks are more than one standard deviation below their historical averages in term of price-to-earnings and price-to-book.

‘We need to remember that valuations have always rebounded after a crisis. We saw that after the 2008 global financial crisis. Hong Kong stocks at current valuations are equivalent to bonds yielding
10% to 15% percent annually,’  he adds.

Mark Asquith, lead manager of the Somerset Emerging Markets Discovery Fund (BK5SP81), describes the sell-off in emerging markets as a ‘once in a generation opportunity’.

He says: ‘The last down market of similar severity occurred during the financial crisis of 2008/09. From the lows of November 2008, emerging market small caps rose more than 150% is US dollar terms in a little over 12 months. Brazilian small caps rose around 300% over the same period and almost 500% within two years.

‘No two bull or bear market is the same, but we could see similar moves from current levels over the next few years,’ he adds.

STABLE INCOME

In terms of sustainability of yields, Mike Kerley, manager of the Henderson Far East Income (HFEL), points out that while companies in the US and Europe have rushed to cut their dividends, outside of Australia and Singapore there is less need for Asia Pacific firms to cut payouts.

‘Earnings undoubtedly will come under pressure but we are confident of the Asian region’s ability to pay dividends owing to the large levels of cash on balance sheets, and most importantly the lower level of dividend payout of only 35%, which is far lower than Western peers and means dividends are more sustainable in Asia than elsewhere.’

He highlights the banks as a good example, given the regulators’ demands in the UK and Europe that they halt dividend payments. He says Asian banks are well capitalised, have lower dividend payout ratios than Western peers, and in a lot of cases are state-owned where the governments rely on dividend income to bolster revenue.

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